Banks EMEA Norway

The Major Sparebanken of the SpareBank 1 Alliance The Sparebanken Benefit from a Supportive Operating Environment

Special Report │ 13 January 2020 fitchratings.com 1

Banks EMEA Norway

The Major Sparebanken of the SpareBank 1 Alliance The Sparebanken Benefit from a Supportive Operating Environment

SpareBank 1 Alliance Regional Market Shares Strong Franchises, Regional Concentrations The ratings for SpareBank 1 SR-Bank (SR-Bank; A-/Stable), SpareBank 1 SMN (SMN; A-/Stable) and SpareBank 1 Nord-Norge 37% (SNN; A/Stable), which are members of the Sparebank 1 Alliance 35% (collectively: the Sparebanken), reflect their stable and low-risk business models, healthy profitability, resilient asset quality and sound capital ratios. The ratings also factor in risks arising from volatility in oil prices, high property prices, geographically 22% concentrated lending and liquidity management in the context of the banks’ wholesale funding reliance. SNN’s ratings are one notch higher than its Sparebanken peers’,

30% reflecting better asset-quality metrics, limited oil exposure and a more retail-oriented business model. 23%

39% 27% 3% Supportive Operating Environment

18% 8% Oslo: The Sparebanken’s performances are closely linked to that of the 9% 12% 24% 12% 31% 16% Norwegian economy and their respective regions, given their 9% regional focus. Fitch Ratings expects the Norwegian banking sector to continue to benefit from the country’s favourable economic Shading reflects strength of market share in the region. environment. However, the Sparebanken remain dependent on oil- Source: Fitch Ratings, SpareBank 1 Group Research related industries, although to varying degrees. A major part of impaired loans at end-September 2019 was related to this industry. Traditional Banking Business Models The Sparebanken’s business models have proven stable due to their focus on traditional banking and their relatively simple organisational structures. The Sparebank 1 Alliance brand is Related Research established throughout Norway as one of the country’s most recognised financial brands with about one million retail SpareBank 1 SMN - Ratings Navigator (September 2019) customers and market shares of about 20% in retail banking and SpareBank 1 SR-Bank - Ratings Navigator (September 2019) 15% in corporate banking. SpareBank 1 Nord-Norge - Ratings Navigator (September 2019) Reduced Exposure to Offshore Industry SpareBank 1 SMN (January 2020) The Sparebanken’s asset quality is strong and compares well with SpareBank 1 SR-Bank (January 2020) international peers’. Impaired loans were a low 60bp-170bp of gross loans at end-September 2019. We do not expect further oil- SpareBank 1 Nord-Norge (January 2020) related asset-quality weakness, although individual cases may still emerge. The banks have also reduced their exposure to the offshore industry in general and to the offshore service vessel Analysts (OSV) segment in particular in recent years. Francis Dallaire Earnings Supported by Rate Hikes +46 85510 9444 The Sparebanken have good profitability, which we expect will [email protected] continue in 2020. The banks benefit from resilient revenue,

reflecting stable banking models weighted towards traditional Image Erik Rankeskog commercial banking, and supported by their strong regional +46 85510 9445 franchises and the SpareBank 1 Alliance. Net interest income (NII) [email protected] has recently been supported by raising policy rates in Norway. Image

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Banks EMEA Norway

moderate price increase in recent quarters. Additionally, Fitch Supportive Operating Environment believes there is a better balance between demand and supply Strong and Resilient Norwegian Economy compared with previously. Fitch believes that central Norway, where SMN operates, has a Low Interest Burden and Modest Increase in Housing reasonably diversified economy. Northern Norway, where SNN Prices to Disposable Income operates, is supported by a large and stable public sector, strong Belgium Switzerland Denmark Finland growth in tourism and faster economic growth in recent years than France Netherlands Norway Sweden the Norwegian average. Rogaland, the centre of Norway’s oil (Households with heavy financial burden industry and SR-Bank’s main market, has faced pressure in the due to housing costs, % end -2018) most recent downturn but macroeconomic conditions have 30 improved significantly over the past two years. 20 10 Resilient Norwegian Economy 0 (%) GDP mainland Norway (LHS) 0 20 40 60 80 Offshore activities (LHS) (Development of the house price to disp. Income ratio between 2000 and 2018 -%) GDP growth Norway (RHS) Size of bubbles represents real price development of housing since 2000. GDP growth mainland Norway (RHS) Source: Fitch Ratings, Eurostat, OECD 100 6

80 4 In contrast, there are signs of overheating in the commercial 60 property market. Fitch believes that prices are rising fast, 2 40 especially in Oslo. The Sparebanken do not have significant 20 0 exposure to the commercial real-estate market in Oslo, where 0 -2 overheating risks are most visible. Fitch believes that overheating

risks are lower in the banks’ regions.

1987 1991 1995 1999 1971 1975 1979 1983 2003 2007 2011 2015 Source: Fitch Ratings, Statistics Norway Strong Regulator Enforces Conservative Risk Appetite Fitch expects the Norwegian banking sector to continue to benefit The Norwegian regulatory environment is highly developed and from the country’s favourable economic environment. The transparent. In recent years, the authorities have introduced a economy has proven resilient to the weaker global growth in 2019. range of measures to tackle rising property prices and household Fitch expects growth to rise to 2.5% in 2019 driven by internal debt. The rules in the diagram below were introduced in 2015 and demand and supported by strong spillover effects from large again renewed recently, hence effective until 31 December 2020. petroleum investments, high capacity utilisation and positive labour market dynamics. The Norwegian economy is still dependent on oil-related activities. 85% LTV at Origination High Property Prices, but Risks Are Modest Max 60% Amortisa- LTV for Nominal house prices in Norway have increased significantly in the tion Secundary req. homes in past decades, in comparison with peer countries. Oslo Underwriting High Property Prices Standards for Morgage Index Lending (1993=100) DNK FIN NOR SWE EA 5% stress 10% on interest flexibility 700 burden quotaa 600

500 5x debt-to- 400 income 300 200 100 a The flexibility quota is defined as the share of loans for which Norwegian banks can

deviate from the requirements. These are reported quarterly to Finanstilsynet.

2003 2008 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2004 2005 2006 2007 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 EA: European Area Average In March 2019, the EU’s Capital Requirements Directive IV and Source: Fitch Ratings, OECD Capital Requirements Regulation were incorporated into the However, the increase in house prices in relation to disposable European Economic Area Agreement. Once fully implemented in income has been more modest compared with peers. Owing to low domestic regulations, they are expected to lead to positive impacts interest rates and strong wage growth, Norway has one of the on Norwegian banks’ capital ratios due to the introduction of SME lowest shares of households with heavy financial burden due to discounts and the removal of Basel I floors. The Norwegian housing costs in Europe. With 95% of residential mortgage loans Financial Supervisory Authority (Finanstilsynet) and the Ministry being flexible rates, debt service burdens could escalate if interest of Finance have stipulated that these rules’ implementation should rates were to rise faster than expected. However, we believe that not lead to a decrease in capital. The Ministry of Finance has the risks for overheating in the residential property market are decided to increase the systemic risk buffer requirement to 4.5% modest as recent macro-prudential measures have led to a more from 3.0% and to introduce risk-weight floors for residential (at

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Banks EMEA Norway

20%) and for commercial real-estate (at 35%) exposure. In addition the countercyclical buffer has increased to 2.5% from 2.0%, Stable Business Models effective as of 31 December 2019. Peer Ratings Navigator The Sparebanken’s overall risk-weight densities are more Operating Company Manage- Risk Financial Profile Viability Environ- Profile ment & Appetite Asset Earnings & Capitalisati Funding & Rating conservative compared with peers. ment Strategy Quality Profitabil- on & Liquidity ity Leverage Conservative Risk Weights in Sparebanken aaa aaa (%) Risk weight density (LHS)ᵃ Leverage ratio (RHS) 90 (%)9 aa+ aa+ 80 8

aa Bank aa

70 7 -

SR SNN 60 6 SMN 50 5 aa- aa- 40 4 30 3 a+ a+

20 2

Bank

Bank Bank

a - a -

10 1 -

SNN

SMN

SMN

SNN

SR

SNN

SMN

SR SR 0 b 0 SNN

SNN SMN SR-Bank Average peers Bank

Bank

Bank Bank

a- - a-

-

SNN -

a Risk weight density measured by RWA/total assets -

SMN

SNN

SMN SNN

SR

SR

SNN

SMN

SR SMN b SR

From left to right: end-2010 to end-Spetember 19 for Sparebanken and end-2018 Bank SMN

bbb+ - bbb+

for peers SR Source: Fitch Ratings, Banks bbb bbb Higher influence Norwegian insolvency laws are tough and function properly. Moderate influence Combined with significant customer data transparency, including Lower influence the national debt register, this creates a significant incentive for households not to default on mortgage obligations. The Sparebanken further mitigate the default risks through low Independent Regional Savings Banks in Nationwide average loan to value (LTV). More than 90% of mortgage loans at Alliance SNN, SR-Bank and Sparebank 1 Boligkreditt AS (S1B) (no In 1996, SNN, SMN and SR-Bank founded the Sparebank 1 disclosure for SMN) have an LTV below 85%. Alliance along with Sparebanken Vest and Samspar, a group of smaller savings banks. Sparebanken Vest withdrew from the MREL Requirements Announced venture in January 2004 to pursue an independent strategy. The Regulation for minimum requirement for own funds and eligible Alliance is the second-largest banking group in Norway, behind liabilities (MREL) was entered into Norwegian legislation in 2019 DNB ASA, with total lending of about NOK850 billion at end-2018. in connection with the implementation of EU’s Bank Recovery and Resolution Directive. The resolution authority (Finanstilsynet) The Sparebanken operate as universal banks for retail and SME communicated specific requirements for each of the Sparebanken customers in their respective regions, where they hold leading in December 2019. The subordination requirement must be market shares (at least 30%) in deposits and loans. They also fulfilled before end-2022 and the Finanstilsynet has stated that operate in surrounding regions, although often with a lower banks will not be able to use senior preferred debt to meet their market share. The Alliance has national market shares of about requirements, which is why we expect the banks to gradually 20% in retail banking and 15% in corporate banking. replace their senior debt with senior non-preferred debt. The The Sparebanken have diversified into areas such as real-estate Sparebanken have MREL ranging from NOK34 billion (SR-Bank) to brokerage and accounting services. The Alliance banks jointly own NOK19 billion (SNN). We believe the requirements will be SpareBank 1 Gruppen AS (S1G), which holds the stakes in the manageable for the Sparebanken within the framework of specialised subsidiaries in life-insurance, non-life insurance, asset ordinary maturities of their outstanding senior unsecured debt. management and factoring services. S1G’s non-life insurance entity, SpareBank 1 Skadeforsikring AS, merged with DNB Forsikring AS to create Norway’s third-largest and fastest growing non-life insurer, Fremtind (in which S1G holds 65%). Combined, these additional revenue streams create earnings diversification and stability for the member banks. Clear and Long-Term Strategic Focus The Sparebanken’s strategies are well articulated and focused on providing core banking services to their regional customers. The management teams are experienced with a fair degree of stability. This, combined with the banks’ retail-focused business models, has resulted in high revenue stability in the past decade, compared with peers. NII and net fees and commission are the main contributors to operating income. Management’s execution records have been strong.

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Banks EMEA Norway

Cost Base Benefits from the Alliance Fitch’s asset-quality metrics do not include loans sold to S1B. The Alliance banks benefit from co-operation agreements These are predominantly high-quality retail mortgage loans. between the members in areas ranging from marketing and IT to Taking these loans into account, SNN’s impaired loans ratio would risk modelling. They own S1B, which has traditionally been their fall to about 40bp, SR-Bank’s to about 110bp and SMN’s to about funding vehicle for residential mortgage covered bonds. 130bp at end-September 2019. The Sparebanken’s loan portfolios are predominantly in retail Sparebank 1 Boligkreditt AS (S1B): S1B issues covered bonds mortgage loans. Corporate exposures are generally diversified and buys mortgage loans from the individual savings bank in although regionally concentrated. SR-Bank has a greater the alliance. The owners of S1B are legally bound to provide proportion of exposure to the real-estate and offshore sectors, liquidity and capital support to S1B in case of need. They would SMN is relatively more exposed to the agriculture sector and SNN provide capital if S1B’s common equity Tier 1 ratio decreases to the real-estate sector and the fishing industry. below the regulatory requirement and subscribe to new Low Risk Loan Portfolios covered bond issues in case there is a disruption in the covered End-September 2019 bond market. Retail loans Real estate Service industry Fishing & agriculture Offshore Manufacturing To mitigate credit risk, S1B only buys mortgage loans with an Other corporate LTV at or below 75% and has the right to off-set any losses SR-Bank incurred on individual mortgage loans against the commissions due to all banks for the remainder of the calendar year. S1B SNN has not had to use this off-set mechanism. SMN S1G is also responsible for some product development and 0 20 40 60 80 100 marketing activities, which creates scale benefits for its members. Source: Banks, Fitch Ratings (% of total loan portfolio incl loans transfered to S1B) This, combined with improvements at the individual Sparebanken, has resulted in better cost efficiency than peers’. Sharply falling oil prices in 2014-2016 translated into asset-quality pressure among certain portfolios. Losses from their OSV Increasing Efficiencya in Sparebanken exposure were the main driver of SMN’s and SR-Bank’s loan Average peers Average Sparebanken impairment charges (LICs) in 2016-2018. The OSV segment SMN SNN (%) SR-Bank remains characterised by oversupply, ageing fleets and high fixed 70 costs, despite recent indications of a more favourable economic 65 environment and higher activity. 60 SNN is less exposed to the offshore industry as the north of 55 Norway’s economy is less dependent on oil-related activity. This 50 translated into lower loan losses during the oil-crisis compared 45 with the other Sparebanken and continues to partly explain SNN’s 40 2010 2011 2012 2013 2014 2015 2016 2017 2018 9M19 better asset-quality metrics. a Efficiency measured as non-interest expenses/gross revenues LICs Linked to Oil Prices Source: Fitch Ratings, Banks SMN (LHS) SNN (LHS) Financial Profile (EURm) SR-Bank (LHS) Brent spot price (RHS) (USD) 180 120 160 100 Note on Peer Charts: Peer average includes Caja Rural de Navarra, 140 Sociedad Cooperativa de Credito (Viability Rating (VR): bbb+), SMN (a- 120 80 100 60 ), SNN (a), SR-Bank (a-), Leeds Building Society (a-), Belfius Bank 80 SA/NV (a-), Nykredit Realkredit A/S (a), Coventry Building Society (a-), 60 40 de Volksbank N.V. (a-), Skipton Building Society (a-), ABN AMRO Bank 40 20 N.V. (a) and Santander UK Group Holdings plc (a). 20 0 0 Black dashed lines in charts represent indicative quantitative ranges 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 and corresponding implied scores for Fitch’s core financial metrics for Source: Fitch Ratings, Banks banks operating in environments that Fitch scores in the ‘aa’ category. In 2019, offshore exposures still account for the majority of Stage 3 loans (impaired loans). Losses from the retail segment have been Resilient Asset Quality very limited and we believe that they will continue to be very low The Sparebanken’s asset quality is sound and compares well with due to conservative underwriting standards, a well-functioning international peers. Impaired loans were low to modest at end- labour market and an advanced social infrastructure backed by the September 2019, between 60bp-170bp of gross loans. SMN’s sovereign wealth fund. A significant property price correction is a impaired loans ratio increased by 31bp in 9M19, driven by a few key sensitivity for the banks, but we do not expect such a scenario individual customers. to lead to significant deterioration of quality in the banks’

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Banks EMEA Norway

mortgage lending. A sharp correction in house prices could result Policy Rate Hikes Support Net Interest Income in reduced private consumption that would negatively affect Policy rate Margin retail depositsᵃ banks’ SME portfolios. SNN and SR-Bank are less exposed to this Margin corporate depositsᵃ risk due to relatively lower house prices in the north and south- 2.0 west of Norway. 1.5

Sound Impaired Loans Ratios 1.0 Impaired loans/gross loans 0.5 Average 2015-2017 0.0 End-2018 (%) End-September 2019 -0.5 End-September 2019 (including loans sold to S1B/S1N) SNN SMN SR-Bank 2.0 From left to right: 1Q16 to 3Q19 a a 1.5 As reported by the banks Source: Fitch Ratings, Banks 1.0 aa Retail lending margins decreased to a degree in 2019 as a result of 0.5 rising Norwegian Interbank Offered Rate and higher competitive 0.0 pressure. Corporate lending margins have been more stable. Fitch SMN SNN SR-Bank Average peers expects more competitive pressure in a rising rates environment. Source: Fitch Ratings, Banks Commission income has been steadily increasing as a proportion of Reserve coverage by loan allowances is good and ranged from 44% total revenue for the Sparebanken, a result of the Alliance banks’ of impaired loans for SR-Bank to 100% for SNN. We believe that focus on the cross-selling of ancillary products, such as insurance, the banks’ reserve coverages are solid given robust wealth management and real-estate brokerage. collateralisation, underpinned by moderate LTV ratios and healthy lending diversification by industry (although regionally The Sparebanken performed well in 9M19 helped by large gains of concentrated). non-recurring nature from the creation of Fremtind and from valuation gains in S1G’s life-insurance entity. Excluding these, the Good Reserve Coverage Average 2015-2018 banks still generated operating profit/risk-weighted assets ranging Loan loss allowances / impaired loans (%) Sep-19 from 2.5% (SR-Bank) to 2.9% (SNN). Since 2016, the 100 Sparebanken’s profitability metrics have been supported by modest LICs and healthy loan growth. LICs have decreased to a 80 low 4% in 9M19 from an average of 20% of pre-impairment 60 operating profit for the Sparebanken at the peak in 2016. 40 20 Strong Profitability at Sparebanken 0 Operating profit/RWA SMN SNN SMN SNN SR-Bank Average Peers (%) Data for peer banks is end-June 2019 SR-Bank Average peers 5 Source: Fitch Ratings, Banks aa 4 We believe that the supportive operating environment, strict 3 underwriting standards and their low risk appetite have helped the a Sparebanken maintain their strong asset-quality metrics and we 2 expect these to remain strong. 1 bbb Strong Performance, Supported by Rate Hikes 0 2015 2016 2017 2018 9M19 The Sparebanken have good pre-impairment profitability, and we expect this will also be the case in 2020. NII has been supported by Source: Fitch Ratings, Banks raising policy rates in Norway. Norges Bank increased its policy Sound Capitalisation, Strong Leverage rate on four occasions since June 2018 to 1.5% from 0.5%, going against the general trend. By keeping deposit rates stable, The Sparebanken’s capital ratios compare well with those of Norwegian banks have been able to benefit from these rate hikes international peers. The use of internal ratings-based models is through higher deposit margins. marginal, resulting in higher risk density and, hence, strong leverage ratios in a European context. Reported Basel leverage ratios ranged from 7.4% (SMN) to 7.9% (SNN) at end-September 2019, compared with a minimum regulatory requirement of 5% (for domestic non-systemically important banks in Norway). Unreserved impaired loans were less than 6% of Fitch Core Capital for the three banks at end-2018, a low level compared with most peers.

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Banks EMEA Norway

Low Risk in Sparebanken 130% (SNN) to 200% (SR-Bank), excluding loans sold to S1B. When End-September 2019 including loans sold to S1B, the Sparebanken all have a ratio Unreserved stage 3 as % of CET1 ranging from 180% to 200%. Accumulated loan losses since 2010 in % of CET1 8 Reliant on Wholesale Funding End-September 2019 Retail deposits Corporate deposits 4 Government deposits Covered bonds (incl. loans sold to S1B) Senior unsecured Subordinated

SR-Bank 0 SMN SNNᵃ SR-Bank SNN a SNN's loan loss allowance fully covers gross stage 3 loans at end-September 2019 Source: Fitch Ratings, Banks SMN The Sparebanken have been building buffers over their minimum 0 20 40 60 80 100 regulatory requirements, and Fitch expects these to be (% of total funding) maintained, even taking into account the recent increase in the Source: Fitch Ratings, Banks counter-cyclical buffer requirement to 2.5%. Fitch expects the Sparebanken to continue to retain access to the Strong Capital Positions capital markets, particularly for covered bond issuance. The relatively small size of Norway’s domestic funding market means End-September 2019 CET1 ratio CRR/CRDIV that covered bonds and senior preferred notes are issued within Total capital ratio Basel leverage ratio (%) Norway in krone and abroad, predominantly in euro. International CET1 SREP req. funding creates a larger investor base, but could prove less reliable 30 25 in times of stress. Fitch believes the banks will retain significant 20 liquidity portfolios to mitigate the risk. 15 10 Sound Liquidity 5 Liquidity reserve to wholesale funding 0 Long-term wholesale funding (excluding covered bondsᵇ SMN SNN SR-Bank Average peersᵃ (NOKbn) Short-term wholesale funding (excluding covered bonds)ᵇ Liquidity reserveᵃ a End-June 2019 used for peers. 60 Source: Fitch Ratings, Banks 50 40 Fitch believes the Sparebanken need to maintain strong capital 30 ratios to offset their regional focus, since a negative development 20 in regional economies, although not our base case, could affect the 10 banks’ management buffers. 0 SMN SNN SR-Bank Reliance on Wholesale Funding, Sound Liquidity a Cash with central banks, net interbank assets and fixed income assets in level 1/2 b Senior unsecured debt, subordinated debt and hybrid capital The Sparebanken rely on wholesale funding to varying degrees, Source: Fitch Ratings, Banks with SNN’s funding mix being slightly more deposit-based. The The banks’ liquidity portfolios predominantly consist of highly banks use covered bonds funding through S1B and Sparebank 1 rated (AA or higher) Nordic covered bonds and other central bank- Naeringskreditt AS (S1N), although due to the ownership structure eligible assets. Contingent liquidity sources include loan sales to of these issuing entities, their balance sheets are not consolidated. the covered bond vehicles. The Sparebanken conduct internal Indirect use of wholesale funding is not included in the bank’s stress tests and maintain sufficient liquidity to be able to continue reported balance sheet. At end-September 2019, the Sparebanken to operate without access to the wholesale markets for 12 months, had transferred up to about 30% (SNN) of total lending to S1B and based on their assumptions. The liquidity coverage ratios (LCR) S1N. Since 2015, SR-Bank has decreased the amount of loans sold were 153% for SR-Bank, 144% for SNN and 181% for SMN at end- to S1B. Instead, SR-Bank set up its own covered bond entity, SR- September 2019. Boligkreditt AS. The Sparebanken’s funding profiles benefit from stable regional deposit franchises, with loans/deposits ratios ranging from about

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Banks EMEA Norway

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